Romania needs all the natural gas it can reach. It is not a question of better budgets, anymore, neither it is something good to have for a stronger economy, more jobs, or empowered local communities. It is a matter of covering the basic needs of the people and businesses, as each molecule is necessary for keeping the national natural gas transmission system running. We publish today a large interview we conducted with two officials from Serinus Energy, an international oil company with operations in Romania and Tunisia. Calvin Brackman, Vice President of External Relations & Strategy Serinus Energy, and Alexandra Damașcan, President of Serinus Energy Romania, answered our questions about the chances for Romania to access new domestic gas.

What is the current situation in the investment climate in new Romanian gas production?

Over the last decade, onshore natural gas production in Romania has steadily declined, while natural gas consumption has steadily increased. This has resulted in the amount of foreign imported gas flowing into Romania having increased significantly. Production from natural gas fields declines over time as natural field reservoir pressure declines. In order to grow production, producers need to bring on new fields at a total rate of production greater than this declining production. However, the past decade has demonstrated that there is inadequate investment in developing new gas fields to even cover the natural decline of existing fields. There are numerous reasons for this including the diminishing size of remaining undiscovered gas fields that result in less production per dollar invested, the fiscal regime, and the expected market price for natural gas.

Romania has been exploring for and producing natural gas for many decades. As is common for mature hydrocarbon basins, most of the large and highly productive fields are discovered and exploited first. Over time, the undiscovered field sizes become smaller and less economic than larger discoveries. All exploration involves a high degree of risk being taken on by the companies making the investment. They can spend considerable at-risk capital and end up not finding gas resources or finding gas resources in a pool of insufficient quantity to be economically produced.

In order for these smaller, less economically attractive fields to be developed, the government fiscal regime becomes an important factor that influences the level of investment. The higher the fiscal burden applied to gas production, a higher productivity rate per invested dollar is required for a gas discovery to be economic. This further increases the exploration risk. This is currently the largest contributing factor to the declining investment in onshore exploration and production activity in Romania. The current government fiscal policies do not adequately reflect the risks that companies face with their investment. Investors need to be relatively confident that their investment in exploration will result in a gas discovery of sufficient size to be developed economically. That the investment capital is earned back with a reasonable return and that once the investment has been made there will be a stable system to help with predictable returns.

The result of this fiscal imbalance is that less gas is ultimately produced, which results in a market reaction in which the gas price goes up for all consumers and that imports of foreign gas are required to make up for the supply shortfall.

What has been the impact on Romania from this under-investment in onshore exploration and production?

The lower investment has resulted in declining domestic production, while at the same time gas demand in Romania has steadily increased. This has resulted in higher gas prices. In effect, the higher fiscal take the government has imposed on producers is passed onto the consumer in the higher prices they pay for their energy. The more capital the government takes out of the system in the form of fees and taxation the less capital there is to invest in growth. This price response is somewhat dampened by the increasing imports of foreign gas into the Romanian market, but this also has a huge cost on Romania in the outflow of funds from the country in payments to foreign gas producers. Since the beginning of 2020, Romania imported over 4 billion cubic metres of foreign gas which has resulted in an outflow of over $1.5 billion from Romania at average market prices during this period. This is a 1.5 billion dollars sent out of the country that otherwise could have been invested to grow production and create domestic jobs.

This foreign imported gas is not subject to the same taxes as locally produced domestic gas. Imported foreign gas is actually exempt from the Romanian Windfall Tax and therefore has a competitive advantage in the Romanian market. Bizarrely the Romanian government is incentivizing the import of foreign gas at a very high cost to the state of Romania as opposed to incentivizing the development of more domestic gas. The funds that flow out of the country to pay for foreign imported gas are not invested back into the Romanian economy.

How can Romania increase its supply of natural gas?

The most important thing Romania can do to increase the domestic supply of natural gas is to incentivize investment in the development of domestic onshore production. Implementing regulatory and fiscal policies that can encourage domestic onshore gas production to grow and make Romanian gas more competitive than foreign imported gas. Given the ease of access and lower capital cost of onshore gas versus offshore gas the onshore system, whilst smaller opportunities can be very quick to develop. Creating an investment environment where domestic and international companies and capital can work to increase production from Romania’s considerable natural resources is key. The economic benefits would be incredible for the country as the increased investment would create jobs, provide increased economic growth, long term fiscal stability, ensure the energy security of the country and its consumers, and provide the gas required as a transition fuel for the development of a low-carbon economy. With the right policy and fiscal framework, Romanian onshore gas production could grow to the point of being able to export excess supply to neighboring countries and earn valuable export inflow revenue for the country. Romania becoming an energy exporter to the EU would shift it from paying for foreign gas to be imported to receiving payment for its’ exported natural gas, thereby becoming a growth engine for the Romanian economy rather than a burden.

What is to be changed in the local regulatory and fiscal framework in order to streamline the activities of current operators and to attract new investments?

Primary laws such as Petroleum Law, Electricity and natural gas Law and their applicable norms should be modified or replaced with new ones, offering to investors streamlined regulatory and permitting processes, efficient and certain title transfer procedures/assignment procedures, recognizing the obligations in a contractual relationship between several co-Titleholders, and provide better and consistent correlation between Petroleum Law and Environmental Law and Water Law. These are changes that would improve the investment climate for gas exploration and development in Romania.

On the fiscal side, the Windfall tax is a damaging tax that is hindering investment. The Windfall Tax needs to be changed urgently to allow the Government to receive a fair portion of the benefits of growth whilst allowing investors an opportunity to earn back their invested capital before paying considerable funds to the Government. For Serinus, we are a gas producer with investment plans to increase our production in Romania significantly, but we must rely on the cash flow we earn from our current operations to fund our future investments. The Windfall Tax as it is currently constructed takes funds away from the business before the projects have had the opportunity to repay the original investment. This structure adds years to the payback period for investors. The longer it takes for us to earn a return on our capital, the longer it takes to re-invest this capital in further exploration and development. The result is slower production growth.

The windfall tax as it is currently structured is a significant disincentive to investment. It acts as a disincentive due to the very high incremental fiscal burden it imposes at the very low gas threshold price of 47 lei/MWh. The rate of burden is 60% at this threshold with no deductibility of operating costs, very limited deductibility of capital costs, and only the deductibility of royalties paid. This is not a windfall tax but a revenue tax. Companies must pay a significant portion of their revenue prior to even earning back their at-risk investment. The fiscal burden becomes even more extreme at the second Threshold gas price of 85 lei/MWh, where the government take increases to 80% of revenue less royalties and companies can no longer further deduct the capital it has spent on exploration and development. Since these threshold prices are not indexed to inflation, as the cost of exploring, developing and operating gas fields goes up, the burden will become even more pronounced and further impede investments going forward. This fiscal burden also does not account for the production decline that happens to all gas fields. This means that producing fields will be shut in sooner as the production revenues can no longer cover the costs of operating the field. Considerable resource volumes could be left unproduced due to this very inflexible and burdensome tax.

The recent historical increase in the gas price in Romania demonstrates how the windfall tax diminishes the market supply response from domestic gas producers. Beyond the 85 lei/MWh threshold, the government takes almost all of the incremental revenues earned above this price. Producers therefore do not adequately react to the price signals of the market. It is said that the cure for high prices is high prices; this is because higher prices incentivize an increase in production and that increase ultimately brings prices back down. The Windfall Tax as it is currently constructed removes this market incentive for growth and in its place shortens the life of existing production. The tax also increases the size of a discovery that is required to be economically developed. Essentially this tax forces producers to leave smaller discoveries unproduced. This lack of supply response will further distort the gas market and make higher gas prices a fait accompli.

The government faces a tremendous economic opportunity. They can design a fiscal system in which they can earn a fair and reasonable fiscal take, while allowing investors to earn back their capital and generate excess capital for reinvestment in the country’s onshore gas opportunities. Over time, the production can grow to eliminate the costly need to import foreign gas. This will help to reverse the huge outflow of funds used to pay for this foreign imported gas, further enhance the energy security of the country and its consumers, use the domestic gas production to replace more carbon-intensive energy sources currently employed in the country, all while maximizing the long-term fiscal return and stability to the country’s finances. The windfall tax as currently designed trades off these long-term benefits of gas and energy self-sufficiency for short-term government financial gain.

Do you think the new NAMR Licensing Round would be of any interest to investors?

Currently, the ability to earn financial returns in Romania, even with higher commodity prices, is lower than in many other countries. The competition for capital does not need to be a race to the lowest tax returns but the current Romanian tax regime is perceived as being unfair to investment. Companies like Serinus invested heavily only to find the Windfall Tax was implemented permanently and our economic returns were severely diminished. This uncertainty is unhelpful. Investors look for fairness and predictability and can move their investment to regimes where they see these practices of fairness and predictability. Romania is currently losing investment to other jurisdictions where investment is incentivized. As mentioned above, with the right policy incentives in place that provide a more reasonable sharing of the benefits to cover the significant risks faced in exploring new gas resources, then investors could be very interested in the new licensing round. To incentivize interest in the new Licensing Round, major improvements on the current Petroleum Law and Fiscal Regime should be pursued. This would include a commitment to fiscal stability that needs to be clearly mentioned in the legislative changes, in order to provide the certainty required to attract investors.

What is different in how an independent O&G company works from how large companies like Romgaz and OMV Petrom treat a field?

Independent Companies rely on equity and cash flow generated from their operations to re-invest for growth. If returns are low, there is little scope or incentive for additional investments. Smaller independent companies also have lower internal costs. They can use this to their advantage and target smaller fields that can be developed profitably that large companies could not develop profitably. Independent companies are an important mix to the development of any natural resources as they will not have many assets all over the world. They will tend to have smaller more localized investment programmes that will highlight the returns available outside of a large company’s portfolio.

The Government promises new gas distribution pipelines in the next years – do you expect such developments to encourage investments in E&P?

New gas distribution and transmission pipelines on their own will not incentivize investment. The gas shortage in Romania is not due to there being insufficient gas transportation capacity, but rather the lack of investment capital to develop more gas production. If incentives to develop more production were successful and production increased to a level that new distribution was critical, then pipeline expansion would be an issue. Currently, it is not an incentive to further investment.

Is there any chance of a stronger incentivization from the authorities to make better use of the gas resources Romania still has in its onshore underground?

Serinus believes that Romania could be an energy leader in Europe. We believe that a fairer and more balanced tax system combined with streamlined permitting and approval processes could be a potent combination in attracting further investment. Serinus does not just think this is the case… We are told so by our investors.

What can Romania do in order to position itself as a solution for the gas problem in the Republic of Moldova?

The Moldova situation highlights the tremendous danger in having to rely on foreign gas suppliers to meet a country’s gas consumption requirements. Many countries have no domestic resources and are dependent upon foreign energy supplies. Romania is gifted with abundant natural resources and with proper policies can be energy self-sufficient and even become an energy exporter. This is where having the right policies enacted can grow Romanian production and allow for volumes to be exported and benefit from other countries looking to diversify their gas supply.

The Russian approach to the gas supplying for Europe is rather troublesome for Romania. What role might domestic gas play in this complicated regional game?

Romania has the resources capacity to be energy self-sufficient and no longer reliant on expensive foreign gas. There is a plentiful supply of onshore resource opportunities that could be developed if properly incentivized and would eliminate the need for Romania to be dependent on expensive foreign gas imports. Romania has a competitive advantage in natural gas given its geo-strategic location and needs to maximize this advantage to become a major player in the regional energy market.

This reliance on Russian imported gas also poses a significant risk to the energy security of Romania as Russia has in the past demonstrated their proclivity to use Europe’s dependence on Russian gas imports to pursue other political objectives. With the expected reductions in Russian gas transiting through Ukraine, this could restrict the future imports that are available to Romania, further complicating the supply in the Romanian gas market.

Please, give us some numbers to illustrate how relevant the independent gas producers in Romania are / might be!

The BP Statistical Review of World Energy is one of the predominant data sources for energy statistics. In the 2021 edition, the Statistical Review of World Energy estimates that Romania has 2.8 trillion cubic feet of proven natural gas reserves. At current production levels, these reserves will last 9.1 years. Compare that with Ukraine which has 38.5 trillion cubic feet of proved reserves that could last, at current production levels for 57.5 years. The difference is not that Ukraine has better geology for gas production, it is simply that more exploration has been focused on the onshore Pannonian basin in Ukraine and more reserves have been found. Ukraine does not have the distraction of large offshore developments that take many years to bring onstream but rather has been focused on the near-term delivery of onshore gas in order to reduce its dependence on foreign imported gas from Russia. Romania can pursue the same development strategy and whilst not disregarding the long-term attractiveness of offshore gas and incentivizing the deliverability of the near-term onshore developments.

Beyond the gas volumes and the financial benefits, the onshore operations in mature, nearly depleted fields request modern technologies and up-to-date know-how. What does this mean for the Romanian O&G industry?

Certainly, the extraction of hydrocarbons from older more mature fields poses difficult challenges but Romania also has the opportunity to develop new gas fields as Serinus has done with the Moftinu Gas Development project. Both require technical skills and Romania is well-positioned through its excellent educational and training facilities to provide the knowledge and workforce to develop both old and new gas fields. No country has a monopoly on oilfield technology. Such technology moves across borders freely. Well-educated and well-trained workforces are less mobile and this is an important competitive advantage that Romania has.